Derek, what is the Santa Claus rally?
During this festive time of year we experience bright lights decorating our city, stockings hung with care, holiday music on the radio, and of course the Santa Claus rally.
While most of these are familiar, the Santa Claus rally isn’t necessarily a familiar holiday discussion in your house (although it is in mine). As most things go during this time of year, there is also some tradition and lore involved with the Santa Claus rally.
So what is it?
The Santa Claus rally doesn’t have to do with an annual car race with men dressed in red and white suits (although I’m sure that could also be a tradition somewhere if you went looking for it). In fact, the Santa Claus rally has to do with a belief, or a theory, that the stock market moves up notably as we head into the end of the year.
Just like any good holiday story, there is some inkling of truth to this one.
The true definition of the Santa Claus rally is an increasing period in the stock market involving the last five trading days of the year and the first two of the new year. This was a phenomenon written about by Yale Hirsch and was called the “December effect.”
One of the concepts at work is that investors are actively selling their losing investments heading into the end of the year to create losses for tax purposes.
On the flip-side, investors are not willing to sell their winning investments until January so as not to create a gain in this calendar year.
While all of this might seem to be a lot of work, the concept is that investors want to push out their tax obligation by nearly an entire year, and they can do this if they hang onto their winners until January.
With this in mind, there isn’t much point in selling a winner during the last few days of the year. The other side of this is that there is benefit in selling your losers because you may be able to use that tax loss immediately.
So putting it all together, since no one is selling their winners, the value in those stocks tend to rise going into the end of the year.
The losers may continue to decline as added selling pressure mounts. It could also be that Wall Street and Bay Street are feeling the effects of good cheer heading in to the end of the year.
So what happens when we get into January?
You guessed it, there is another phenomenon called the January effect. In direct comparison, investors who waited to sell their winners now begin to sell shortly after they sing Auld Lang Syne and welcome in the new year of trading. All of this selling pushes the value of the winners lower.
Meanwhile, the losers from January are looking attractive because of all the selling pressure going into the end of the year, and as such investors begin piling back into these names, thus increasing their value. Specifically, small company stocks seem to benefit more as we get into January.
Now with all this talk about the calendar and timing your investments, one needs to step back and understand whether any of this actually works.
The reality is that tax-loss selling certainly does occur and it can be a valuable strategy. How it impacts the market isn’t always notable and certainly impossible to predict.
The truth is that sometimes there is a Santa Claus rally, and sometimes there is not. Sometimes stocks move higher in January, and sometimes they do not.
To add to the Santa Claus rally, there are a number of market hypothesis to follow, including the old adage, “Sell in May and go away,” as well as the observation that markets “always” move lower in September.
Whatever each theory states, the reality is that various times of the year have varying degrees of impact on the markets.
The problem is that they are impossible to predict to any degree of certainty.
So what does the average investor do? My opinion is tax-loss selling is a valid strategy that needs to be discussed further. With that in mind, if you’re a long-term investor focused on the future you should ignore the Santa Claus rally and focus instead of spending time with friends and family, and that the only red or green you should be concerned about are the lights outside your house.
From my family to yours: season’s greetings and all the best in 2015.
Wealth Watch is written by Derek
Fuchs, a wealth advisor with ScotiaMcLeod in Red Deer. It is provided for informational purposes only. Readers are urged to consult a wealth advisor for help with their personal investment circumstances. Fuchs can be contacted at firstname.lastname@example.org.